Note: don't assume information for trading sessions will be the same as that given in the case descriptions. The information (interest rates, etc.) will be displayed by the system at the beginning of the session.
In the FTS markets, stock prices will evolve in continuous time, but you can trade only at discrete points in time. Your trading performance is evaluated by the amount of money you make as well as ensuring that the market value of your position does not fall below a pre-specified floor. This guarantees that the profits from option writing activities do not fall below target levels.
In the FTS markets you will have access to a set of real-time analytical support tools that enable you to monitor the delta and gamma of your position at each point in time.
In ST1, you can access additional support windows by first clicking on the menu item Support in your Trading Screen. Once you have initialized this support system you will automatically see the market value, delta and gamma of your position in real time. By clicking on any Option label in this Option Support Window will popup and update an option calculator support window.
Each time you want to update the calculator be sure to click on the option label in the Option Support window first.
FTS markets are open for approximately six trading months, but time is condensed so that one week is equal to 15 seconds. Prices adjust every week and your position is marked to the realized market prices at the end of six months.
THE STOCK MARKET
Trading in this stock is permitted at the displayed bid/ask prices that are updated weekly. At the end of six months each share you own is marked to the realized market price.
The time to maturity for each option is approximately six months and the terminal payoff for each option depends upon the realized value for IMB after the FTS markets are closed.
For example, options with a strike price equal to 320, have the following terminal values:
Terminal Value:
Call Option = Max[Marked value – $320, 0]
Put Option = Max [$320 - Marked value, 0]
At the end of their life, options are automatically exercised if they are "in the money."
If you are type A then you have an initial non-tradable position in call options. If you are type B this non-tradable position is in put options.
| Type A | Endowments |
| Treasury Strips | 113 units |
| Call 320 | -1,000 shares |
| Put 320 | 0 |
| Call 360 | 0 |
| Put 360 | 0 |
| Type B | Endowments |
| Treasury Strips | 45 units |
| Call 320 | 0 |
| Put 320 | +1,000 shares |
| Call 360 | 0 |
| Put 360 | 0 |
Implicit in each initial position is a "profit" from writing call options (put options) to clients at prices slightly higher than theoretical prices.
In both cases, this profit is approximately $53,500 market cash, and your trading objective is to lock into a floor to this profit for the firm.
Option trading is not permitted. Therefore, you must manage your position's exposure to price risk by only trading in the stock and treasury markets.
Shortselling in the stock and treasury markets is permitted. This allows you to borrow (lend) at the risk-free rate by shortselling (buying) treasury strips.
Holding market cash pays zero interest and borrowing is not permitted in the cash market. If you want to buy securities but have insufficient cash you must first shortsell the required amount of treasury strips and then purchase the desired amount of stock.
The spot risk-free rate of interest for a Treasury strip is currently 3.25% per annum. This rate is not expected to change over the next 6 months.
At the start of a trial, your initial endowment is either type A or type B, and an independent path for the stock prices is generated (starting from the spot price of 347).
If at the end of any trial you have a closing balance of $45,000 market cash then you will earn $6 of grade cash. If you have a closing balance of market cash that is lower than $45,000 then you will earn $0 of grade cash. Any amount of market cash that is greater than $45,000 and less than or equal to $200,000 earns grade cash as follows:
Grade Cash = $6 + [(Ending Balance of market cash - $45,000)/ 155,000] x $4
Above $200,000, market cash earns the maximum grade cash for one trial, which is $10.
Trading is conducted over a number of independent trials and a record of your cumulative grade cash is maintained.
If you do not have a copy of this program, you may download a program that works for Windows 95 or NT now [this is a self-extracting ZIP file that you must install on your computer to read PDF files]. If you want the current version of the Adobe Acrobat Reader for other platforms, visit Adobe's web page.
Click here to download this assignment.
A histogram showing the grades for this quiz is available in Acrobat's portable data format (.pdf). The file is about 34K and can only be viewed (and printed) using a copy of Acrobat Reader.
Click here to download this graph.
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